all about trade finance

7/29/2019 All about Trade Finance

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TRADE FINANCE

BY: NAYAN JAIN(12)SWAPNIL KHANVILKAR(19)GIRISH MENGHANI(26)NIDHI SOMANI(31)

SUKHADA SAOJI (44)TUSHAR SHINDE(52)


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INDEX

1) Collection of Bills

2) Letter of credit

3) Advanced payments4) Open account system

5) Factoring

6) Forfeiting


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Collection of bills

A method of payment in international trade

Customers pay their bills at any of the banks branches.

Mechanism:- Exporter dispatches goods to importer

- Instructs the bank to send the shipping documents to theimporters bank .

- Importers bank acts on behalf of exporters bank to collect paymentfrom the importer.

- Bill of Exchange

- Shipping documents are released only when payment or acceptancehas been made.


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Exchange rate risk:

- Its a permanent risk that will remain as longas currencies remain the medium of

exchange.- Companies quote a price for the goods

using a reasonable exchange rate

- But, economic events may upset even thebest laid plans

- Currency hedging is used to avoid the risks.


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Pre shipment finance:- Issued by financial institution when the seller wants the payment of

goods before shipment

Post shipment finance:- Issued by financial institution to a seller against a shipment that hasalready been made.

Bill discounting:- Banks take bills drawn by the seller towards his customer and pays the

seller immediately deducting some amount as discount/commission

- Seller banks responsibility to send documents and bill of exchange to

buyers bank .


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LETTER OF CREDIT

A letter of credit is a document issued by theissuing bank on behalf of buyer to the sellerwhich promises to pay for the goods or

services on completion of stated terms. Players

Buyer Applicant

Seller Beneficiary Buyers Bank Issuing Bank

Sellers Bank Advising Banks


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Buyer/ApplicantSeller/

Beneficiary

Issuing BankAdvising Bank

Carrier

Buyer and Seller Contract

Bill of

ladingPayment

Bill of lading

Payment

Bill of

ladingPayment


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UCP 600

Uniform Customs and Practices for documentary credit

600 came into existence on July 1, 2007

UCP 600 Application (Article 1)

Irrevocable and Revocable credits(Article 2) Definition and Interpretation (Article 2 & 3)

Expiry Date (Article 6)

Time Allowed Banks for Document Review (Article14)

Non-Matching Documents (Article 14)

Non documentary requirement

Original Documents (Article 17)


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Open Account System

Open accountalso called open creditinvolves

delivery of your goods or services to the buyer with

an invoice requesting payment at a certain time after

delivery.

Applicability:

Secure trading relationships Competitive markets


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Characteristics

Risk: Intentional defaults

Ability to pay

Delayed payment

Pros: Boost competitiveness in market

Building trust

Cons: High risk of non-payments Currency exchange rate risk


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Advanced payments

An arrangement whereby the Exporter is

trusted to ship the goods after receiving

payment from the Importer.

The Importer sends payment directly to

the Exporter and waits for the Exporter to

send the goods and documents.


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Characteristics

Advantages to Exporter:

Assumes no risks

Disadvantages to Exporter:

None

Disadvantages to Importer:

Assumes all risks

Opportunity cost of using companys cash resources until

goods are received.


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INTERNATIONAL PAYMENTS RISK

SPECTRUM

LEASTRISK TO

IMPORTER

HIGHESTRISK TO

IMPORTER

HIGHESTRISK TO

EXPORTER

LEAST RISKTO

EXPORTER

Open Account

Payment in Advance


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FORFAITING

Forfait is derived from French word A Forfaitwhich means surrender of fights.

Forefaiting is a mechanism by which the right forexport receivables of an exporter (Client) ispurchased by a Financial Intermediary (Forfaiter)without recourse to him.

It is different from International Factoring in asmuch as it deals with receivables relating todeferred payment exports, while Factoring dealswith short term receivables.


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FORFAITING (contd)

Exporter under Forfaiting surrenders his right for claiming payment forservices rendered or goods supplied to Importer in favour ofForefaiter.

Bank (Forefaiter) assumes default risk possessed by the Importer.

Credit Sale gets converted as Cash Sale.

Forfaiting is arrangement without recourse to the Exporter (seller)

Operated on fixed rate basis (discount)

Finance available upto 100% of value (unlike in Factoring)

Introduced in the country in 1992.


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MECHANICS OF FORFAITING

EXPORTER IMPORTER

FORFAITER AVALLING BANK

HELD TILL MATURITY

SELL TO GROUPS OF INVESTORS

TRADE IN SECONDARY MARKET


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ESSENTIAL REQUISITES OF

FORFAITING TRANSACTIONS

Exporter to extend credit to Customers for periods above

6 months.

Exporter to raise Bill of Exchange covering deferred

receivables from 6 months to 5 years.

Repayment of debts will have to be avallised or

guaranteed by another Bank, unless the Exporter is a

Government Agency or a Multi National Company.

Co-acceptance acts as the yard stick for the Forefaiter to

credit quality and marketability of instruments accepted.


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IN FORFAITING:-

Promissory notes are sent for avalling to theImporters Bank.

Avalled notes are returned to the Importer.

Avalled notes sent to Exporter.

Avalled notes sold at a discount to a Forefaiteron a NON-RECOURSE basis.

Exporter obtains finance.

Forfaiter holds the notes till maturity orsecuritises these notes and sells the ShortTerm Paper either to a group of investors or toinvestors at large in the secondary market.


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CHARACTERISTICS OF FORFAITING

Converts Deferred Payment Exports into cash transactions,providing liquidity and cash flow to Exporter.

Absolves Exporter from Cross-border political or conversionrisk associated with Export Receivables.

Finance available upto 100% (as against 75-80% underconventional credit) without recourse.

Acts as additional source of funding and hence does not have

impact on Exporters borrowing limits. It does not reflectas debt in Exporters Balance Sheet.

Provides Fixed Rate Finance and hence risk of interest ratefluctuation does not arise.


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CHARACTERISTICS OF FORFAITING

(contd.) Exporter is freed from credit administration.

Provides long term credit unlike other forms of bankcredit.

Saves on cost as ECGC Cover is eliminated.

Simple Documentation as finance is available against bills.

Forfait financer is responsible for each of the Exporterstrade transactions. Hence, no need to commit all of hisbusiness or significant part of business.

Forfait transactions are confidential.


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COSTS INVOLVED IN FORFAITING

Commitment Fee:- Payable to Forfaiter by Exporter in

consideration of forefaiting services.

Commission:- Ranges from 0.5% to 1.5% per annum.

Discount Fee:- Discount rate based on LIBOR for the period

concerned.

Documentation Fee:- where elaborate legal formalities are

involved.

Service Charges:- payable to Exim Bank.


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FACTORING vs. FORFAITING

POINTS OFDIFFERENCE

FACTORING FORFAITING

Extent of Finance Usually 75 80% of the

value of the invoice

100% of Invoice value

Credit Worthiness Factor does the creditrating in case of non-

recourse factoring

transaction

The Forfaiting Bankrelies on the

creditability of the

Avalling Bank.

Services provided Day-to-day administration

of sales and other alliedservices

No services are

provided

Recourse With or without recourse Always without

recourse

Sales By Turnover By Bills


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COMPARATIVE ANALYSIS

BILLSDISCOUNTED

FACTORING FORFAITING

1. Scrutiny Individual Sale

Transaction

Service of Sale

Transaction

Individual Sale

Transaction

2. Extent of

Finance

Upto 75 80% Upto 80% Upto 100%

3. Recourse With Recourse With or Without

Recourse

Without

Recourse

4. Sales

Administration

Not Done Done Not Done

5. Term Short Term Short Term Medium Term

6. Charge

Creation

Hypothecation Assignment Assignment


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WHY FORFAITING HAS NOT

DEVELOPED Relatively new concept in India.

Depreciating Rupee

No ECGC Cover

High cost of funds High minimum cost of transactions (USD 250,000/-)

RBI Guidelines are vague.

Very few institutions offer the services in India. Exim Bank

alone does. Long term advances are not favoured by Banks as hedging

becomes difficult.

Lack of awareness.


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STAGES INVOLVED IN FORFAITING:-

Exporter approaches the Facilitator (Bank) for obtainingIndicative Forfaiting Quote.

Facilitator obtains quote from Forfaiting Agencies abroadand communicates to Exporter.

Exporter approaches importer for finalising contract duly

loading the discount and other charges in the price. If terms are acceptable, Exporter approaches the Bank

(Facilitator) for obtaining quote from Forfaiting Agencies.

Exporter has to confirm the Firm Quote.

Exporter has to enter into commercial contract. Execution of Forfaiting Agreement with Forefaiting

Agency.

Export Contract to provide for Importer to furnish avalledBoE/DPN.

:


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:-(contd..)

Forfaiter commits to forefait the BoE/DPN, only againstImporter Banks Co-acceptance. Otherwise, LC would be

required to be established.

Export Documents are submitted to Bank duly assigned in

favour of Forfaiter. Bank sends document to Importer's Bank and confirms

assignment and copies of documents to Forefaiter.

Importers Bank confirms their acceptance of BoE/DPN to

Forfaiter. Forfaiter remits the amount after deducting charges.

On maturity of BoE/DPN, Forfaiter presents the instrument

to the Bank and receives payment


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FORFAITING:- (contd..)

Export Documents are submitted to Bank duly assigned in

favour of Forfaiter

Importers Bank confirms their acceptance of BoE/DPN toForfaiter.

Forfaiter remits the amount after deducting charges.

On maturity of BoE/DPN, Forfaiting Agency presents the

instruments to the Bank and receives payment


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WHAT IS FACTORING ?

Factoring is the Sale of Book Debts by a firm (Client) to a financialinstitution (Factor) on the understanding that the Factor will pay

for the Book Debts as and when they are collected or on a

guaranteed payment date. Normally, the Factor makes a part

payment (usually upto 80%) immediately after the debts are

purchased thereby providing immediate liquidity to the Client.

PROCESS OF FACTORING

CLIENT

FACTOR

CUSTOMER


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Characteristics of Factoring

The normal period of factoring is 90 days and rarely exceedsmore than 150 days.

It is costly. Credit rating is not mandatory.

Factoring is not possible in case of bad debts.

It is a method of off balance sheet financing.

Cost of factoring is always equal to finance cost plus operatingcost


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SERVICES OFFERED BY A FACTOR

Follow-up and collection of Receivables from Clients.

Purchase of Receivables with or without recourse.

Help in getting information and credit line on customers

(credit protection)

Sorting out disputes, if any, due to his relationship with Buyer& Seller.


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PROCESS INVOLVED IN FACTORING

Client concludes a credit sale with a customer.

Client sells the customers account to the Factor and notifies

the customer.

Factor makes part payment (advance) against account

purchased, after adjusting for commission and interest on the

advance.

Factor maintains the customers account and follows up for

payment.

Customer remits the amount due to the Factor.

Factor makes the final payment to the Client when the

account is collected or on the guaranteed payment date.


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MECHANICS OF FACTORING

The Seller sells goods to the buyer and prepares invoicewith a notation that debt due on account of this invoice isassigned to and must be paid to the Financial Intermediary.

The Seller submits invoice copy only with Delivery Challanshowing receipt of goods by buyer to the Factor.

The Factor after scrutiny of these papers allows paymentThe balance is retained as Retention Money. This is alsocalled Factor Reserve.

The drawing limit is adjusted on a continuous basis after

taking into account the collection of Factored Debts. Once the invoice is honoured by the buyer on due date, the

Retention Money credited to the Clients Account.

Till the payment of bills, the Factor follows up the paymentand sends regular statements to the Client.


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CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of

Debts purchased) (0.50% to 1.50%)

Commission is collected up-front.

For making immediate part payment, interest charged.

Interest is higher than rate of interest charged on Working

Capital Finance by Banks.

If interest is charged up-front, it is called discount.


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TYPES OF FACTORING

Recourse Factoring

Non-recourse Factoring

Maturity Factoring

Cross-border Factoring


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RECOURSE FACTORING

Upto 75% to 85% of the Invoice Receivable is factored.

Interest is charged from the date of advance to the date of

collection.

Factor purchases Receivables on the condition that loss

arising on account of non-recovery will be borne by the Client.

Credit Risk is with the Client. Factor does not participate in

the credit sanction process.

In India, factoring is done with recourse.


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NON-RECOURSE FACTORING

Factor purchases Receivables on the condition that the Factor

has no recourse to the Client, if the debt turns out to be non-

recoverable.

Credit risk is with the Factor. Higher commission is charged.

Factor participates in credit sanction process and approves

credit limit given by the Client to the Customer.

In USA/UK, factoring is commonly done without recourse.


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MATURITY FACTORING

Factor does not make any advance payment to the Client.

Pays on guaranteed payment date or on collection ofReceivables.

Guaranteed payment date is usually fixed taking into accountprevious collection experience of the Client.

Nominal Commission is charged.

No risk to Factor.


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CROSS - BORDER FACTORING

Exporter (Client) enters into factoring arrangement withExport Factor in his country and assigns to him exportreceivables.

Export Factor enters into arrangement with Import Factor

and has arrangement for credit evaluation & collection ofpayment for an agreed fee.

Notation is made on the invoice that importer has tomake payment to the Import Factor.

Import Factor collects payment and remits to Export

Factor who passes on the proceeds to the Exporter afteradjusting his advance, if any.

Where foreign currency is involved, Factor coversexchange risk also.


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STATUTES APPLICABLE TO FACTORING

Factoring transactions in India are governed by the

following Acts:-

a) Indian Contract Act

b) Sale of Goods Act

c) Transfer of Property Act

d) Banking Regulation Act.

e) Foreign Exchange Regulation Act.


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WHY FACTORING HAS NOT BECOME

POPULAR IN INDIA

Banks reluctance to provide factoring services

Banks resistance to issue Letter of Disclaimer (Letter of

Disclaimer is mandatory as per RBI Guidelines).

Problems in recovery.

Factoring requires assignment of debt which attracts StampDuty.

Cost of transaction becomes high.

STAGES INVOLVED IN EXPORT


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STAGES INVOLVED IN EXPORTFACTORING

Exporter (Client) gives his name, address and credit limitrequired to the Export Factor.

Export Factor submits the details of Buyer to the ImportFactor.

Import Factor decides on the credit cover and

communicates decision to Export Factor. Export Factor enters into Factoring Agreement with

Exporter.

Overseas Buyer is notified of this arrangement.

Exporter is then free to ship the goods to Buyers directly. Exporter submits original documents, viz., invoice and

shipping documents duly assigned and receives advancethere-against (upto 80%).


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FACTORING (contd..)

Export Factor despatches all the original documents to

Importer/Buyer after duly affixing Assignment Clause in

favour of the Import Factor.

Export Factor sends copy of invoice to Import Factor in theDebtors country.

Import Factor follows up and receives payment on due

date and remits to Export Factor.

Export Factor, on receipt of payment, releases the balanceof proceeds to Exporter.


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